Calpers Buy-Hold Rule Recoups $95 Billion Recession LossMichael B. Marois
The California Public Employees’ Retirement System is poised to top a record $260 billion in assets, the market value it held before the global financial crisis wiped out more than a third of its wealth, by sticking with a strategy of buy-and-hold.
The largest U.S. public pension, with half of its money in publicly traded equities, was worth $253.2 billion on Jan. 17, or about 97 percent of the pre-recession high set in October 2007. The fund returned 13 percent in 2012, about the same gain as the Standard & Poor’s 500-stock index achieved.
“A lot of the improvements in portfolio returns is simply reflective of the return of the market,” Chief Investment Officer Joe Dear said in an interview. “But there is still an important lesson there, which is that when the crisis was full on, we didn’t drastically reduce our equity exposure.”
Calpers isn’t alone in nearing previous high marks. The 100 largest public pensions in the U.S. had $2.9 trillion in assets in the fourth quarter of 2007, according to U.S. Census Bureau data. That dropped to $2 trillion in 2009 and rebounded to almost $2.8 trillion as of Sept. 30.
The median funded status of state pensions, meaning how much money a system has in order to pay its obligations, fell to 72 percent in 2011 from 83 percent in 2007, according to data compiled by Bloomberg.
Even with its gains, the Sacramento-based pension is still short $87 billion, or about 26 percent, of meeting its long-term commitments, and has had to ask the state and struggling cities to contribute more. One municipality, San Bernardino, sought bankruptcy protection, saying it can’t afford to pay $13 million it owes to Calpers.
“It’s certainly good news that the asset base has grown and recovered,” said Bradley Belt, senior managing director of the Milken Institute and former executive director of the federal Pension Benefit Guaranty Corp. “The bad news is that while you’ve gotten back to where you were on the asset side -- through a combination of good market returns and new contributions -- liabilities never took a holiday. Liabilities are now a whole heck of a lot larger than they were.”
Calpers’s value was already in decline when Lehman Brothers Holdings Inc. went bankrupt in September 2008, leading to a panic that wiped out more than $6 trillion in U.S. stock-market value in about six months. By 2009, Calpers’s value had plummeted to $164.7 billion.
Since then, the pension fund has benefited from the stock market’s recovery after the Standard & Poor’s 500 Index touched a 12-year low in March 2009. The benchmark gauge of U.S. equities climbed more than 13 percent last year and has more than doubled since its low.
Apart from stocks, Calpers invests about 17 percent of its money in bonds, 14 percent in private equity, 9 percent in real estate, 4 percent in cash-equivalents, 4 percent in inflation-linked holdings such as commodities, and 2 percent in forestland and infrastructure such as airports and power plants.
“We held on to our allocation,” the 61-year-old Dear said. “We believed the markets were going to come back and we held our allocation at around 50 percent and that decision has been justified.”
In the years following its record losses, the fund also restructured its money-losing real-estate holdings, trimmed the number of private-equity managers it deals with, embraced more risk controls, built up a pool of cash and taught managers to better coordinate between asset classes.
After Calpers’ real-estate portfolio lost almost half its value by the end of the 2009 fiscal year, Dear set out to shrink leverage used to make purchases, got rid of underperforming managers, focus on core income investments such as rental apartments, industrial parks, offices and retail space. It also sold off a fifth of its speculative residential housing.
The real-estate unit returned almost 13 percent in 2012, averaging 6 percent in the past three years, though that’s still below its internal target of 10 percent.
Dear also encouraged the fund’s board to increase cash and Treasuries holdings in what he calls a “liquidity bucket” to have money on hand if needed quickly.
That’s because in 2008, the pension, which loaned shares to broker-dealers and short sellers for a fee, was forced to dump huge blocks of its stock holdings to raise cash as clients redeemed their loans. In the third quarter of 2008, Calpers for example sold 2.3 million shares of Apple Inc. for about $370 million, a stake that would have been worth $1.16 billion today.
Dear also restructured the fund’s private-equity unit, reducing the number of external managers while pushing for lower fees and better terms. From fiscal 2006 through 2008, Calpers committed $36.7 billion to external private equity managers; from fiscal 2009 through 2012, that fell to $5.2 billion, according to figures the fund provided. Private equity was up 12 percent for the year as of Dec. 31, about half its benchmark.
“It takes a long time for a private-equity portfolio to reflect decisions to improve it,” Dear said. “What I found was a portfolio with too many general partners and too many funds. That was a problem from a portfolio-management standpoint, but more importantly it dragged the portfolio toward the average.”
“To obtain the return premium we expect from private equity, the plus 3 percentage points, you really have got to have the largest proportion of your assets with the best managers,” he said. “Private equity is the case in point that taking a short-term view is like pulling up a carrot to see how it’s growing.”
While the fund targets a 7.5 percent annual return, it spreads gains and losses over 15 years to reduce the volatility in the amount it asks taxpayers to provide through employer contributions for pension benefits.
The state and local governments paid $7.8 billion to the fund in the last fiscal year to cover the cost of those benefits, almost four times more than a decade earlier.
Calpers and other public pensions have come under fire for assuming unrealistically high rates of return on invested assets. The rate can mask how much is really needed to cover benefits promised to government workers. A lower figure would require more from taxpayers to cover the costs.
Governor Jerry Brown, a Democrat, and lawmakers last year enacted a package of bills that caps pension benefits for public workers and requires new employees to pay for half of their pension costs. The same savings will be sought from current employees through bargaining with their unions to lower projected obligations as much as $55 billion over 30 years.
“It is encouraging to see improvement in Calpers returns for the 2012 calendar year, which signals a better second half of the year for the pension fund,” said state Senator Mimi Walters, a Republican from Irvine who is vice-chair of the Public Employment and Retirement Committee. “However, I wouldn’t call a modest improvement a resurgence.”
“The massive losses the fund has experienced over the last five years will take more than one 13 percent annual increase to be considered a resurgence,” she said.